For Indian markets, the outlook is cloudy

Mumbai: India’s bellwether stock index Sensex on Tuesday slid below this year’s lowest level of 14,677.24 recorded in March before it closed at 14,889.25, down 176.85. Market analysts now fear that the index could fall below 13,779.88, a level it had tested in mid-August 2007, after India’s stock market regulator clamped down on offshore investment instruments and the first signs of subprime crisis emerged in the US.

Meanwhile, Indian corporations are preparing themselves to live in a “hostile environment in the next 12-18 months”, says Prabal Banerji, the chief financial officer of the Hinduja Group.

He expects inflation to rise further, hurting corporate profitability. According to him, companies will also find it difficult to raise capital for business expansion.

“Availability of capital is a major cause for concern with valuations going down in a weak equity market. To complicate matters, interest rates may also rise making money dearer,” says the finance chief of a Mumbai-based metals firm who does not wish to be identified.

Most executives and fund managers expect a monetary tightening move by the Reserve Bank of India through a rate hike or a rise in banks’ cash reserve kept with the central bank, even both.

Subir Gokarn, chief economist of rating agency Standard and Poor’s in the Asia Pacific region, however, says that “there are a number of factors driving the current situation which are outside the control of a central bank.”

While the current situation is worrisome, it is “not out of control”, says Shuchita Mehta, senior economist of Standard Chartered Bank.

The bigger concern, according to her, is not inflation or growth, which might recover in 2009-10, but the government’s finances.

The government will pay the price for the fiscal burden it is incurring to keep the economy running smoothly, she says.

“When you give subsidy or oil bonds that keep sitting on your book, at some point of time you need to redeem it or you continue paying interest,” Mehta adds.

Till March 2008, the Union government has issued about Rs75,000 crore of oil bonds to oil firms as compensation for losses incurred by selling fuel at an administered price lower than the cost of production.

Standard Chartered expects inflation to average 8.7% in 2008-09 and growth to come down to 7.4%.

Surprisingly, Indian bankers do not seem to be worried by the present situation. According to them, there is no credit crunch in the system.

“I don’t see much of a problem here,” says M.D. Mallya, chairman and managing director of the public sector Bank of Baroda. “Liquidity is reasonably good even now. Although the growth has moderated, it could again start gaining pace. Having said that, since oil prices are rising, I think we could expect the central bank to go for hiking cash reserve of banks to contain inflation,” says Mallya.

Sundara Rajan, chairman and managing director of the Chennai-based public sector Indian Bank also says there is “absolutely no problem” and that the Indian economy is far less affected by the global factors than other countries.

“I don’t subscribe to any kind of pessimism,” he adds.

“RBI and the government have initiated several steps to contain inflation and I think we need to give some more time to see the results,” Rajan adds. The most crucial factor for markets is the price of crude oil, which has risen more than fivefold since 2002 and more than 30% in 2008.

Other experts say the monsoon could bring some moderation on food prices.

But foreign institutional investors, or FIIs, the largest investor class in Indian markets, do not seem to be convinced, at least for the time being. They have been selling stocks continuously for the past two weeks. The net FII outflow from India is around $5 billion (Rs21,000 crore) thus far this year after a record inflow of $17.4 billion in 2007.

Mujib Mundewadi, a director in India for US-based fund CarVal Investors, which manages more than $17 billion worth of assets globally, says the fund is sitting on $700 million to $1 billion in cash, which it originally intended to invest in the Indian real estate sector.